Thursday, August 20, 2009

As I woke Monday morning I saw that the Asian markets, particularly the Shanghai Composite, were selling off sharply. And I thought to myself, “oh no, here we go”. My general feeling is that the US equity market is overbought as the valuations haven’t quite caught up to price. Yet the US equity markets finished the day positive. What gives?

It is no secret by now that China is funding US debt through its purchase of US Treasuries with surplus money supply gained from US trade imbalances and China’s peg to the US dollar. As the US dollar declines in value, so does the value of the Chinese Yuan. This in turn makes China’s goods cheaper to the rest of the world, which continues to perpetuate the cycle of Chinese economic surplus.

Now I have nothing against China making money as I am a capitalist at heart, but now it’s time to level the playing field.

China is no longer an emerging economy, but rather the richest nation in the world!

Well actually, they are the third largest by GDP, but considering the massive debt that the US is accruing at an alarming rate, I wouldn’t be surprised to see them move up the list by year end. Which brings me to the point: why do they need to peg their currency to the US dollar, or even a basket of other currencies for that matter?

They want to be a major player on the world stage, yet are acting like impetuous children. Well I say it’s time for China to grow up! China should be forced to allow their currency to float in the free market. While the initial pain may be great, they could mitigate the impact by showing their willingness to work with the other countries around the world and could do it in stages. By some accounts the Yuan could strengthen by 20% to 30% just by removing the peg, not to mention how it would respond to currency markets.

Obviously the feeble attempts at political pressure from the US have failed miserably and now it’s time to get tough. People have become afraid of what will happen if we make them mad at us; will they dump our bonds?? I say who cares, we should threaten to default outright on any bonds they own and not allow them to trade them in the free market if they don’t float. So now they have a choice, either take a 20 or 30% haircut by letting their currency float, or take a 100% loss because we won’t pay them back or accept their currency.

While this is an extreme measure and I’m really being a bit facetious here, they really have been allowed to operate in an unfair economic environment. Should something as radical as I propose happen, I would be long (CNY) or (CYB), two Chinese Yuan ETFs.

At the end of the day, their policies have contributed to global financial catastrophe and it’s time that they admit their role in it and make the changes necessary to fix it. And as was apparent on Monday, the US markets no longer consider China a child, but rather an adult economy with its own problems. It's time for China to grow up!

Otherwise, other countries around the world won’t want to play in the sandbox anymore.

Tuesday, August 18, 2009

Economies move through a series of expansions and contractions known as the business cycle. This should not be news to anyone with even a modicum of financial acumen, yet it amazes me that those who are tasked with understanding this basic concept get it so wrong time after time.

What I am referring to is the need to “call a bottom”. When I started out in my trading career, the trading aphorism I heard most was to not try to “catch a falling knife”. Yet day after day, I see some politician, financial pundit, or media type who will tell you with all certainty that the “bottom may be in” and the recession may be over. What they’re NOT telling you is that just like everyone else, they really have no idea where the bottom may be and that all of their guessing is nothing more than a way to pat themselves on the back at cocktail parties 6 months from now in the random chance event that they were right!

Let’s debunk some of the myths about economic “bottoms” and tell you what you need to know.

Less contraction does not equal expansion! When economists say a recession is over, all they are saying is that economic output has stopped contracting. And while that may be true, the “logical” conclusion that they draw is that if the economy stops contracting, then it must be expanding, which means growth. This couldn’t be further from the truth. Economies can experience long periods of non-growth or stagnation, after having been stabilized. Don’t believe me? Ask the Japanese.

Stock market returns do not equal overall economic conditions! While it’s great that the market has had a good run since the March lows, people are still losing jobs (though less rapidly), banks are still not lending, housing prices have not stabilized, and we have a ginormous mountain of debt to show for it. Now I’m not trying to pee in anyone’s cheerios, but at this moment in time the “logical” conclusion that the economy can’t move back into contraction-mode is WAY too premature.

We may not have a letter of the alphabet to describe this economic condition! While it is convenient for financial pundits and media types to throw around the classic ‘V’ or ‘W’ or ‘U’ shaped bottom comments, I’m not so certain that what ends up happening will resemble anything close to what can be written in the English language. Now while I realize that doesn’t make for engaging cocktail-party fodder, perhaps the back-slappers will just have to sit this one out.

Government intervention may have created false conditions! Now I’m not going to argue whether the stimulus packages were necessary or too much or too little or whatever as only time will tell how effective they were. Of course then I can write an article about the fallacy of assigning specific credit or blame to the stimulus, although that’s another topic entirely. The point is that we can’t necessarily determine what the outcome is until after it occurs. All of the projections and estimates are just educated guesses and should be treated as such going forward.

As you can hopefully see, trying to pick bottoms will leave you with little more than stinky fingers. Rather than trying to guess cause and effect, investors and traders alike should proceed cautiously and really stay focused on what they see and not what they hear. Because if history has taught me anything, it’s that when everyone is saying the bottom is in probably means closer to the opposite.

But rest assured, if they keep calling bottoms, eventually someone will be right. And I’ll be the first one to throw that guy a pizza and ice cream party. But for now, I’ll keep my ears closed and my eyes open.